L8 SRAS Flashcards
First story: Sticky prices. Explain, looking at:
- why would our observations of reality make us think this?
- two types of firms
- what’s the function of prices that flexible price firms set?
- what are the prices that fixed price firms set?
- what does the aggregate price level then satisfy?
- what do we need to do to get to the Pi, Y space? (As the prev solution results in P,Y)
- Observer data suggest stability in retail prices over time, adjustment every 8-11 months on average
- Share of firms (s) have fixed prices - in advance of current period - and (1-s) is the share of firms free to vary. So we get:
P = s x p(s) + (1-s) x p(f)
- p = P + a(Y-Ŷ)
Look at overall prices in economy P, along with the deviation from output as the higher that is the higher marginal costs of inputs would be
- p(s) = P(e) they assume that output will equal its long-run value.
- Ans (1)
- We subtract the price level from the previous time period, with P_-1 being the last period’s log aggregate price level
Second story: Sticky wages
- So explain briefly what’s up; the interaction between labourers and firms
- What do firms really care about?
- What does unexpected inflation do to what firms really care about?
- Up to what point will firms hire labour?
- Do what do higher prices imply?
TO BE CONTINUED CHECK WITH CHARLES
- Workers and firms work together to agree to set a nominal wage in advance.
The agreed wage will be a function:
W=w x P^e - The real wage, W/P, which is the target real wage consistent with classical eq’m multiplied by expected inflation/actual inflation ie P^e/P
- Reduce Wr, which means that firms can now use cheap labour to expand production
- Up to the point where the real wage equals the MPL, assuming CD production function.
This gives as a function for employment as a function of prices - Higher P -> lower Wr -> more employment
Third story: Imperfect information
- What’s the story?
- How’s it different from the previous two?
- What’s the equation?
- Imperfect info. Prices carry information to perfectly competitive producers, giving them the money value, but what they really want to know is what’s real value of their product (correcting for change in value of money in nominal terms)
There’s a Walrasian who rows up and announced nominal prices to islanders, p. They then decide what to produce at this price, as if they increase production the marginal costs rises
If they knew the real prices, perfect competition would ensure p/P = MC(y)
They form expectations of what the price of the product will sell for because they’re rational, and their output. See p>p^e, have to ask themselves:
Is our product superior, in which p/P has grown?
Or has the value of money fallen everywhere?
Gotta place probabilities on both happening!
Nominal price is an imperfect price signal for real demand.
- The previous two assumed a ‘sand in the wheels’ economy where they simply were stuck with sticky prices. This one doesn’t place restrictions on what people can do, but on what they know.
- We have each island setting y higher when p is higher
y = y^e + a(p-p^e)
Which aggregates to give AS
Flaws of sticky P
Why would sticky price firms wanna produce where MR
Flaws of sticky W
Why would the cyclicality be different in real life?
Why would workers be willing to move off their labour supply curves?
Also suggests real wage should be countercyclical:
So as W/P falls, Y rises
BUT irl we see procyclicality-ish
So we would have counter-cyclicality for D-side fluctuations, as moving along AS curve. But might have AS shocks instead
When would we have a horizontal SRAS?
Good to look at curve where Pi (the inflation rate) is expressed in terms of the expected inflation rate plus some v multiplied by aggregate output deviations
If the actual inflation rate met expectations:
1) if the proportion of first that set flexible prices was zero is all of them set it in advance
2) if the proportion of capital share was zero
3) there was no imperfect information, and people would be perfectly aware that there is a zero probability of the aggregate price level P NOT meeting expectations P^e. They know with certainty it’s a relative price change
When would we get a vertical SRAS?
Would be useful to express actual output Y in terms of LR output Ŷ and deviations from inflation expectations multiplied by 1/v
We would end up in our Classical model: Y=Ŷ if
- there were no sticky prices, so s=0
- capital dominates the production function, so changes in the real wage doesn’t do anything to changes in aggregate output
- zero probability (rationally!) on RELATIVE prices deviating from expectations, so they know which certainty that it’s a nominal price change so they shouldn’t change production.
SO vertical SRAS coincides with LRAS
